If you are a property developer, you may not always be able to pre-sell all the units within your development, or your strategy may be to intentionally withhold some units from sale until the development is complete. The unsold units are sometimes referred to as ‘Residual Stock’.
Some lenders are happy to allow you leverage up against the residual stock to enable investment in other areas, such as purchasing your next development site. This type of arrangement is sometimes referred to as a ‘Residual Stock Loan’.
In such arrangements, lenders typically look at the following factors (to name just a few) when assessing the maximum limit they would be willing to consider and extend:
- Concentration – i.e. how many units are you holding in the same complex / location;
- Leverage – depending on the concentration, lenders will generally consider a Loan to Value Ratio (LVR) of between 40% – 70%. This may be on the combined value of each individual unit or (again depending on the lender) on the ‘In One Line’ value, which basically equates to the combined value of the units if sold as one lot (usually a more conservative approach).
- Interest Cover Ratio (ICR) – most lenders require a minimum ICR to qualify that the debt sought can be serviced adequately by the rental income of the units being provided as security. The ICR can range between 1.1:1 – 2.5:1. This basically means that for every $1 of interest payable on the loan, the lender expects net rental income of at least $1.10 – $2.50. This metric can also have an impact on the overall LVR that the lender will allow you to leverage the properties to. For example:
- Assumed Property Value: $4,650,000
- Proposed LVR: 65%
- Proposed Loan Amount: $3,000,000
- Assumed Interest Rate: 3.25% pa
- Interest Expense: $97,500 pa ($3M x 3.25%)
- Net Rental Income (excluding outgoings & GST): $180,000 pa
- ICR Calculation: $180,000 ÷ $97,500 = 1.85:1 (Net Rental ÷ Interest)
The above example suggests that for every $1 of interest payable on the proposed loan, this property is generating Net Rental of $1.85.
Based on the above example, if the lender’s ICR requirement is less than 1.85:1 then generally speaking, you may be able to maximise the LVR. However, if the lender’s ICR requirement is say 2:1 then they may reduce the loan amount such that the minimum ICR requirement is met. We can work this out as follows:
- Divide your net rental figure by 2 because we know that you need $2 of net rental income to every $1 of interest to achieve the required ICR: $180,000 ÷ 2 = $90,000; then
- Divide the new interest dollar amount by the annual interest rate to get your potential maximum loan amount: $90,000 ÷ 3.25% = $2,769,231;
- Therefore, your maximum LVR would be calculated as follows: $2,769,231 ÷ $4,650,000 = 60% (Loan Amount ÷ Property Value)*.
Obviously, there are many other factors which can influence your maximum borrowing amount, loan term and interest rate, such as holding strategy, location, security type and other financial metrics (to name a few more). Furthermore, lender criteria can vary substantially between the majors, non-majors and private lenders.
Residual stock loans can be helpful in order to free up equity which can be reinvested in other productive investments. Here are some examples of how a Residual Stock Loan can be helpful:
- Looking to purchase next development site;
- Needing to contribute further equity into a project;
- Working capital;
- Older buildings within your portfolio may require improvements & maintenance, therefore you may need to release some equity to assist with the same.
So, if you are a property developer or investor and would like to release some equity from within your property portfolio, please feel free to get in touch as we’d be pleased to assist you with your finance requirements.
Disclaimer: The information provided herein is for general information purposes only and does not constitute specific advice. It should not be relied upon for the purposes of entering into any legal or financial commitments. Specific advice should be obtained from a suitably qualified professional before adopting any investment/financial strategy.